A lot of negative news all over the globe and in India. So what is the problem here? Simply put, assume Government is a person. It has borrowed beyond its means. Which means it has more expenses than the revenues it can generate. Which is known as Fiscal Deficit. Also, we are the only country in Asia to run a current account deficit, which means we are saving lesser and investing even lesser.

Like Theoden (King of Rohan - Lord of the Rings) mentions - "How did it has come to this?" (I LOOOVE LOTR!!! Except the silly hobbit Frodo...but that is a seperate post!)

Well, as a nation, we are always capital starved. We grow if we have abundance of capital. But for a typical growth or emerging economy like ours, we tend to overheat occasionally. This requires a firm pat on the head by RBI in the form of interest rate hikes, which in turn cools inflation till things are manageable. So in between the 5 yr bull market of 2004 to 2009, we had an interest rate hike period between Mar 06 & Mar 08. Then a series of cuts all the way till sub 5%.

Of late when inflation started rising again from Mar’10 to Oct’11 we had a series of 13 hikes all the way back to 9%. So this saga continues and there is nothing new in it. Only thing is, this time we were dealing with some mutant form of inflation. A culmination of what started out as supply push and then also involved demand pull inflation. RBI was fighting with ineffective weapons to counter this. What we needed a year back and what we need NOW are fiscal reforms. Simple. There is only so much RBI can do!

So in conjunction with the global weakness, where governments tried to revive economies by pumping money, Companies back home got hit by the twin evils of higher RM costs and Interest costs. Now they are also getting hit on the growth front as private capex has all but vanished due to government crowding out by its massive borrowing program.

 We have enough comfort on valuations. Sample some of this-  

1.      The benchmark indices are trading at below median values. Nifty has traded between 10x and 24x PE band with median of 14.5x, now we are quoting at12x PE (FY13E). A good way of seeing that markets are undervalued.

2.      Another measure we can look at is market cap to GDP ratio. At its peak this ratio was 1.2x and averaged 0.9x and presently its 0.6x, indicating markets are not overvalued.

3.      Market PER of 12x translates into a earnings yield of 8.3% which is roughly equal to G Sec yield. It was below G Sec yield for the past few months. Historically whenever this has happened, we have had mean reversion i.e. markets usually bounce from those levels.

4.      If earnings growth continues at same pace and markets do not de-rate further (less than 12x), then we could see doubling of current market levels in a span of 5 years. This level could move higher if the PE re rates from 12x to 14x (median levels).

I sincerely believe that corporate earnings in India are very resilient. So historically earnings are twice of GDP growth. Even assuming a piffling 6.5% growth this year we should be in the 12-15% range for corporate earnings.

So why are we not buying by truckloads? Well, market multiples are a funny animal and are driven by GDP growth and debt yields, both factors have caused de rating recently. There are serious issues which need to be sorted at the macro level and those take time.  While broadly it’s the twin deficits, other micro issues would be sorting out are the fuel issue for power plants and regulatory road blocks, FDI in retail and aviation, implementation of GST etc. to name a few.

Fiscal Deficit – scary scene when the official figure is Rs5.1tn (5.1% FY13E GDP), my figure would be Rs6tn fiscal deficit on my own GDP estimate so that will translate into a deficit of 5.9%. Similar to FY12, UNLESS we have oil prices coming off drastically or the GOI does a hefty re auction of spectrum or sells a lot of FPOs. Very difficult to see that happening, right?  Oil prices would be crucial here on the subsidy front as the Govt. has targeted subsidies to be 1.7% of GDP in FY13E i.e. Rs1,730bn. Oil may have Rs1,130bn under recoveries in FY13 of which how much the government bears is a fluid question.

But then, money in equity markets is made when valuations are inexpensive. Valuations get inexpensive only during times like these! So when conviction is high and macros are good, we will not get good valuations. Key is to believe that these issues will be resolved in a reasonable time frame.  So it is more of being patient and holding your nerve in these markets. And yes, corny as it may sound….believing in the India Growth Story! Happy Investing…

Ok, so was doing a quick review on various stocks and here is how they look –

Auto sector

1.       MUL (33%) FV 1600 – play on base effect, reasonable valuations at exit multiple of 15x. Headwinds can be currency. Tailwind of RM can play.

2.       Hero Motorcorp – Story largely done and dusted, will be mkt performer with 11% upside

3.       Bajaj Auto – 18% upside for FV of 1900. Can give it 15x exit multiple. Lot of new launches in FY13, export presence hedges it for weaker currency & KTM is the icing.

4.       Ashok Leyland – valuation wise has good upside but cautious w.r.t. to the CV cycle, though on the ground offtake happening. Div yield is the sweetener.

5.       Exide – Will languish at these levels for a couple of quarters but structurally sound

6.       M&M and TTMT – no specific triggers, could see a 15% upside purely on valuation terms

Cap Goods

1.       Only LT seems to be comfortable for FV 1600, a good upside but need to be invested. Headwind of order inflow. But aggressive guidance given by mgt of 15-20% inflow growth which may come in, as FY12 slippages will count plus it is L1 in some bids. E&C has been doing well as a vertical. More insulated than BHEL.

Banks

1.       PNB – not getting comfort on restructured book though looks comfortable in valuations

2.       BoB – only PSU I like. FV 930 on 1.3x BV FY13E. Upside of 27%. Has had some slippages but conservative management and more than adequate cover gives us comfort. Growth in book also better than other PSUs

3.       Axis – Riskier bet due to chunky book. But an upside of 24% from here on 1.5x book. FV 1300.

4.       ICICI Bank – Largest upside amongst pvt banks nearly 47% for FV of 1200 – 2x book. Seasoned NPA profile should hold it in good stead.

5.       HDFC Bank – the king of banks still has about 20% long term upside if we are willing to give it a 4x P/BV multiple for FV of 600

FMCG

1.       Asian Paints, Nestle, Colgate and Unilever all have fantastic growth and business models but little room for upside given the valuations

2.       ITC looks good for another 10% from here given the recent GOI ruling which may enable it to maintain margins on price hikes. (Ad valorem duty scrapped for fixed duty). FV250

3.       Dabur looks good and is putting its distribution strategy in place with its ayurvedic portfolio. FV 120 should give us 14% upside

IT

1.       HCL has the biggest upside, decent numbers, capitalizing on vendor churn. 15x multiple may be a little too soon for this company but on that we get a FV of 570 – 18% upside.

2.       TCS really rich valuations, no buy at 18x multiples, marginal upside at 20x. Difficult to assign in that in current times, but investors have little option with INFY underperforming.

3.       INFY looks good only from a 24 month perspective else valuations do not support.

Power

1.       NTPC – I see a 20% upside based on valuations. Can give it exit P/BV multiple of 1.5x for FV of 175. Stock got beaten down due to lesser PLF thanks to lack of coal availability. That should improve in FY13. As regards capacity expansion, atleast should put in 3GW for FY13.

Oil & Gas

1.       HP/BP become situational plays for price hikes. Cairn is perfectly prices in. ONGC is a function of government subsidy nowadays.

2.       RIL – it’s a technical issue. Will not revive till positive news flows in on KGD6. Buyback offer may not stem the slide. However, may get reversal on recent fine imposed by GOI.

Portfolio Performance

Just a follow up on my last post - My portfolio returns in the last six months below. Please bear in mind this is a concentrated portfolio not aligned to any benchmark however for comparison I have compared it with Nifty. Also, portfolio initiated in mid october with continous ramp up of AUM from Nov to Apr. I guess clearer picture would be to see this portfolio six more months down the line once it is properly seasoned.

	Return	Benchmark Return	Alpha
October-11	-2.08	9.84	-11.92
November-11	-2.59	-9.28	6.69
December-11	-7.33	-4.30	-3.03
January-12	-3.05	12.43	-15.48
February-12	7.97	3.58	4.39
March-12	1.66	1.9	-0.19
April-12	0.38	0.9	-0.56

So you can see 7 data points. 3 months of under performance, 2 months of out performance and 2 flat months. October was when there was very little in the portfolio. Power Grid and BoB did well while PFC, Coal India, BHEL underperformed.

Nov was pretty good in terms of max Alpha. 669bps out performance to Nifty. Largely thanks to Power Grid, BoB, TCS, CIL, LT and ONGC.

Dec a drag due to RIL PFC, LT and Adani Ports (some Scam news). Used the opportunity to buy more.

Jan was worst month because markets rallied, was still in portfolio build up mode and BHEL PFC continued to lag. 

Feb was again a 439bps outperformance to Nifty mainly due to rally in BoB PFC (used to exit partially), LT (sold off to buy later), TCS etc. 

March flattish as gains from HUL ITC were set off by weakness in MM which held steady so far. I continue to hold it. Mid caps like TTK also underperformed but next month they performed , used to exit.

April Auto pack good with hero doing well and TCS steady. Sold Sun, Nestle and TTK for decent gains. Drag due to LT BHEL Hindalco.

Remain Invested!

Last I posted was two months back, how time flies! Anyways, last time I posted, I did mention about how hot money could flow out pretty quickly and be ready to redeploy. Well that theme played out partially with FIIs getting bored with markets post the Budget and RBI Policy. The government chipped in and spooked them some more with the GAAR regulations which threatens retrospective taxation and may bring P Noted within their ambit. Also the rupee is not helping. Its in free fall mode as we speak. So what happened was the beta play of Jan and Feb stopped. People got scared with the massive deficit numbers and sticky inflation. RBI’s outlook more or less indicating this rate cut is all you get for the next 2 quarters and falling growth led to a nose dive into defensives. End result? Broader markets remain range bound. FMCG continues to outperform. Nestle, ITC, HUL take a bow.

So where do we go from here? Q4 numbers are also more or less in line, done with. Market for the interim atleast is searching for triggers. And not many are too encouraging. S&P downgraded sovereign rating of India to BBB- Negative outlook. Now that will spook the firangs even more!

Remain invested. Good thing is from a valuation perspective 13x one year forward gives us comfort. So downside to that extent is protected. What we should bear in mind is probably a significant time correction still ahead of us for the next six months at least. There would be interim opportunities in the meantime. So all is not lost! Stay invested, stick with blue chips for stability. Introduce beta in the portfolio through quality private banks, who are doing surprisingly well and available at decent valuations. Add beta through auto, a proxy to consumption and valuations not as demanding as FMCG. Do take a bit at cap goods through known names like Larsen and Crompton. For the interim, to hedge the deficit, buy exporters like Cipla, TCS. Pick up some quality mid caps along the way, they have really outperformed the markets by a large margin. Risk reward in some cases better than large caps.

Maal Laav!

Enjoy the relief rally! Like I last stated last time, banking stocks and cyclicals have rebounded. Firangs basically have made 22% since January, thanks to rupee and stock returns. So claw backs have been done, returns made, makes sense to book partially and re enter at a later stage. Fiscal situation has not changed overnight but what has happened is global liquidity influx from the ECB's version of the QE i.e. the LTRO, so money has found way to the worst performing emerging market i.e. India. FII flows were $2bn in Jan alone compared to negative last yr. Be swift while getting out once hot money flows evaporate and be ready to deploy money after the correction - Long onlys are waiting for that. The interest rate cycle has almost turned, globally things are more or less stabilising, domestic front reforms seem imminent...there has been a significant time correction in the market whilst earnings have grown ~40% in the last 3 years. So a re rating is inevitable. Time for equities has come! Rejoice!

Q3 revival and market cheer

So the markets have gained 8% in a span of less than a month. Relief rally in a bear market, or genuine revival? The results released so far have been viewed in a positive light with the IT majors being in line or exceeding it, auto companies largely in line though circumspect of the future and the bank NPA bomb has not exploded yet with Axis numbers and HDFC Bnk numbers bearing out.

SO what I mentioned in my last post largely remains true with debt yield locking (M2M strategy) and dipping into equity. I would not be specific sector long, more stock specific, though some sectors like Power, Cap Goods, Infra - largely cyclicals...may take their own time to revive due to macro and policy issues.

What to do for now? Book partial profits in auto, FMCG etc, which has moved smartly, start taking small positions in cyclical names - probably I dare say some banks, even GMR, Suzlon, L&T, ICICI Bank, Axis Bank, M&M, Hindalco, Exide & Adani Ports.

2012 - Renewed hopes or hopes dashed?

2012 has begun, we are trying to be all chirpy and happy. I remember attending a panel last year, where in Madhu Kela, Navneet Munot etc were on the panel (Was Sameer Arora around? My memory fails me). I remember Madhu being cautiously optimistic - saying it will be a stock picker's market, Navneet being circumspect etc. The same note of caution being sounded now. Lets take stock of things now...
PROs: Government finally doing things, we can expect atleast some traction in retail FDI, GST, energy de regulation etc. Probably the fiscal deficit gaps get plug with divestment and buyback strategy, interest rate cycles peaking out, inflation taming off.

CONS: Widening deficit, if rupee remains the same and oil prices where they are, things could get ugly. Some policy paralysis could nullify growth. FII sluggishness will affect our markets.

So my strategy? Play debt in the first half of 2012. Lock in those fantastic yields, play for return or M2M. At the same time, dip a bit in equities, especially the structurally strong business models. Assume 2 quarters of bad numbers. Also, realise that we may see some anemic growth for a while. Its been 7-8 years of continuous growth by corporates, probably that growth may take a breather. 2012 may be more of patience and strategy than a roller coaster ride.